There are no signs that China’s slowdown has bottomed out. A turnround would require some combination of a pickup in investment, exports or consumption in the midst of current efforts to deleverage and this is unlikely to happen soon. More than a decade ago during the Asian financial crisis, China was able to revive growth despite a similarly severe debt problem by tapping buoyant global markets facilitated by its accession to the World Trade Organisation.
But circumstances this time are different. The recovery in the US and Europe continues to be tepid with both parties needing to generate stronger trade balances to support their recoveries. Thus any bounce in exports is likely to be modest and China will face continuing pressures to scale back its trade surpluses with negative consequences for industrial production.
The most significant growth dampener, however, will be a stagnant property market. It will take a year or more to reduce the excess stock of housing. Construction and real estate activities account for about 13 per cent of gross domestic product but linkages with other activities magnify the economic consequences.
Many see a crisis coming because of the fivefold increase in property prices over the past decade. China is different, however, because a national urban property market only emerged about a decade ago after housing was privatised and local authorities began to sell land for commercial development. Much of this seemingly outlandish price increase is not a “bubble” in the usual sense but the result of market forces trying to establish intrinsic values for an asset previously hidden in the socialist system.
But price increases over the past several years have gone too far. A hint of what might be sustainable is when property prices dipped in 2011/12 and then rebounded and continued to rise unlike a typical property bubble. Taking the early 2012 levels as a proxy for sustainable levels, property prices might decline by about 10-20 per cent as part of a forthcoming adjustment. Such a decline would not have an appreciable impact on household balance sheets given their low leverage and accumulated equity, although some developers will sink because of carrying costs.
Without the usual buffers of surging exports and booming investment, some China watchers look to consumption as the salvation. Thus they have been encouraged by signs suggesting that the share of consumption in GDP may have begun ticking upward from its current 35 per cent, the lowest of any major economy. If so, this would indicate that the long-awaited rebalancing of the Chinese economy may finally be under way.
This belief reflects a popular but mistaken perception that China’s unbalanced growth is a barrier to establishing more robust growth. The extended decline in the share of consumption, however, is due to China’s rapid urbanisation cum industrialisation process and follows the pattern of a select group of successful Asian economies (Japan, South Korea and Taiwan). Transfer of workers from agriculture, where labour’s share of production is high, to urban industrial jobs, where labour’s share of production is much lower, leads to a decline in the consumption share of output. In the process consumption per capita increases rapidly since urban jobs are much more productive than rural ones. Thus real consumption per head in China has been growing at 8.5 per cent annually for a decade — the highest of any major economy. But such rapid growth cannot realistically be expected to increase any faster.
In these circumstances, China’s growth rate may continue to decline to about 6 per cent over the coming year or two. This is alarming for those who have warned about employment consequences but the labour force is shrinking and wage increases are still robust. Instead the risks come from a possible escalation in debt servicing costs as the government continues to liberalise the financial sector triggering an increase in interest rates. China’s debt to GDP ratio has surged to about 220 per cent over the past six years and is projected to increase even further. Beijing needs a rebound in the growth rate in the second half of this decade to facilitate the requisite reforms for companies and local governments to deleverage.
Thus far markets have been looking for evidence that China’s leadership will introduce more mini-stimulus programmes, relax constraints on housing purchases and loosen credit policies to arrest the slowdown. These actions will not promote more sustainable growth but will simply result in another round of asset price inflation. The only alternative is to act more forcefully on those parts of the Third Plenum reform agenda which will boost productivity.
Beijing has already acted on one plank in the form of its new urbanisation programme announced in March, but it needs to rethink a key aspect which limits the movement of workers to the major cities in favour of the smaller ones. Since labour productivity is much higher in the largest cities, this restriction makes it harder for the urbanisation process to achieve the requisite productivity gains. The other action that can yield significant near-term growth benefits is allowing more private, including foreign, involvement in protected economic activities. The impact on productivity is potentially the greatest in services, notably finance, education and health, where China has the most restrictive policies among the Group of 20 leading economies regarding foreign participation.
If China can act on these two reform initiatives, together they have the potential of establishing a more sustainable GDP growth rate of at least 7 per cent for the remainder of this decade.